Question

What changes will take place to bring an economy in equilibrium if: (i) planned savings are greater than planned Investment; (ii) planned savings are less than planned investment.

Answer 1

(i) When planned savings is more than planned investment, then the planned inventory would fall below the desired level. To bring back the Inventory to the desired level, the producers expand the output. More output means more income. A rise in output means a rise in I and a rise in income means a rise in S. Both continue to rise till they reach a point where S=I.

(ii) When planned savings is less than planned investment, then the planned inventory rises above the desired level. To clear the unwanted increase in inventory, firms plan to reduce the output till S becomes equal to I.